Public Bill Committee

[Frank Cook in the Chair]

(Except clauses 3, 5, 6, 15, 21, 49, 90 and 117 and new clauses amending section 74 of the Finance Act 2003) - Schedule 2

Capital gains tax reform

Question proposed [this day], That this schedule, as amended, be the Second schedule to the Bill.

Question again proposed.

Frank Cook: Order. I thank members of the Committee for being so tolerant of my decision to change our start time to 1.30 pm. I am very much obliged.

Stewart Hosie: It is a pleasure to see you in the Chair, Mr. Cook. Before we adjourned, I was describing the talk of winners and losers that had taken place in respect of capital gains tax changes and those who sold shares and were due to pay capital gains tax on them. One of the issues that has not been addressed before relates to people who hold share options. As I have said, those options might have been granted as bonuses or rewards for loyalty over time from a company. People might have intended to keep them and exercise them as options; to buy and sell when it was beneficial to them perhaps in large part to fund a special holiday or their retirement. I am not talking about rich people or those in senior management. I remember from my past when ordinary employees of a large plc were routinely granted share options as part of its loyalty and bonus payment system. However, in the case of a takeover, particularly of one plc by another plc, the options have to be crystallised to facilitate the sale or buy-out of the company. The holder of the options may not necessarily want to crystallise the options into shares, but has to as a result of a buy-out or takeover by another company. The employee is then left with an option. They may no longer be employed by the new company, but be surplus to requirements, or may not feel the same loyalty to the new company that they had to the old company, and consider that it was time to sell up. Again, I can think of ordinary workers from my background with that experience.
What consideration has the Treasury given to that particular group of people? I doubt whether it is a large group. With the market being what it is, there is not a lot of takeover activity. None the less, people might have options that are required to be crystallised when they otherwise would not have, but might then choose for a variety of reasons to sell them. They would be liable to capital gains tax under the new regime. I accept that my point is technical and that it has not been raised before, but I should be grateful to know whether the Minister intends to look at that group of people sympathetically or simply say that, once the options are crystallised and the shares are sold, capital gains tax will be paid as it would had the share been held as a share, not as an option.

Jane Kennedy: Welcome to the Chair, Mr. Cook. We said this morning how grateful we were for the licence given to us this afternoon. It was of enormous benefit to those of us who were able to join you at Gwyneth Dunwoody’s funeral.
Schedule 2 delivers the central elements of the capital gains tax reform programme that was announced in the 2007 pre-Budget report, with the changes taking effect from 6 April 2008. Taper relief operated by reducing the amount of a gain before it was charged to tax. That reduced the effective rate of tax paid on the gain in question. The amount of reduction depended on whether the asset being disposed of qualified as a business asset or a non-business asset, and the length of time for which the asset had been owned before its disposal.
The introduction of taper relief in 1998, as we have discussed, was an important part of the Government’s drive to promote investment and reward enterprise. A decade on, we have now delivered an unprecedented period of macro-stability and have established the United Kingdom as one of the best environments for business in the world. We believe therefore that it is now right to reform capital gains tax. The regime remains highly competitive, with a headline rate less than half that in force in 1997. Equally important, the change represents a major simplification of what had become one of the most complex parts of the code.
The reformed capital gains tax regime removes distortions and will be more sustainable and straightforward for taxpayers, helping everyone to plan for the future. Extending taper relief in the way that a number of hon. Members have suggested would not enable the major simplification that we have delivered. We believe that the 18 per cent. headline rate and the 10 per cent. special rate available through entrepreneurs relief represents one of the most simple and competitive regimes of any major economy. That compares very favourably with our competitors in the G7, based on the figures for those countries in 2007. Only Italy has a marginally lower rate of 17.2 per cent. The spread goes as far as the USA, where the rate is 35 per cent., and Japan, where it is 40 per cent. and in both countries capital gains are taxed as personal income. Our preferential CGT rates also bear comparison with international competitors.
I was asked a number of questions about indexation allowance, and we discussed it partly when considering the amendments. Because indexation allowance was frozen in 1998, only a minority of disposals still qualify. I was asked if I had an estimate of the number. The data published by Her Majesty’s Revenue and Customs show that about 17 per cent. of disposals are of assets that have been owned for longer than 10 years.
In a wide-ranging speech, but one which raised a number of sensible questions, the hon. Member for Fareham probed whether there was any way of predicting how the decline of costs would occur. He acknowledges that there is no question but that there will be a decline. I invite him to look at table A3.1 in the Red Book. We do not have a profile that predicts ahead because we do not carry out that type of prediction for future years for this type of measure.

Mark Hoban: I am intrigued. The Government have been able to project the additional tax that will be raised by the CGT reforms. Presumably, to do that they needed to project the revenue that they would gain from the abolition of the indexation allowance.

Jane Kennedy: I will look into the point that the hon. Gentleman raises. The information that I have has already been published, but I will see if there is more that I can share with the Committee in the spirit of being helpful.
The hon. Member for Dundee, East raised concerns about people holding share options. He feared that they might face different capital gains tax rules. We are focusing new relief on entrepreneurs, as we will discuss shortly. The tax paid by people with options will depend on their personal circumstances. It could have been as high as 40 per cent. under the previous regime. The highest that it could now be is 18 per cent. We think that it is right for someone with large share options to pay some capital gains tax.

Philip Hammond: I am interested in what the Financial Secretary has just said because by implication, there could be circumstances in which people with share options will pay less than 18 per cent. and will be eligible for entrepreneurs relief. Will she confirm that, because I have not been able to identify such a possibility?

Jane Kennedy: Based on the advice that I have, the logic of what he is saying is right. It will depend on the circumstances of the individual.

Stewart Hosie: This is very interesting. I confirm that the same rules for options will then apply, so that if one held options to purchase more than 5 per cent. of stock, they would be eligible for the entrepreneurs allowance on crystallisation of the sale in the same way as if they have more than 5 per cent. of the stock in actual shares? Is that correct?

Jane Kennedy: I hope so—[ Laughter. ] I will look at this matter. I believe that my answer is accurate, but I want to double check it in the light of the debate. Let me say one or two more things about share schemes. For the two large all-employee share schemes, the share incentive plan rules include a special provision for shares to be rebased to their current market value when someone leaves the scheme, so that there are no outstanding gains for capital gains tax purposes at that point. Tax returns from companies offering save-as-you-earn schemes show that in 2005-06, the average gain per employee was £2,300—well within the tax-free annual exempt amount. That is why we believe that the vast majority of people who sell shares acquired through tax-advantaged share schemes will not be liable to capital gains tax on those gains. Most gains made will fall within the generous tax-free annual exempt amount of £9,600.
I have seen the evidence that the hon. Gentleman presented from ifs ProShare. We do not believe that that evidence is a proper issue—most people do not come anywhere near HMRC because they fall below the threshold, so there are no figures to demonstrate that what we are saying is accurate. However, because we know what the general value is—as I have said, most gains fall within the generous tax-free annual exempt amount—we are confident that the vast majority of people selling shares in that way are not liable to capital gains tax. It is not something that we have not looked at. We have given it some consideration.
We continue to support employee share schemes, which continue to offer significant tax advantages for those employees who participate in an improved scheme, as well as for those employers who offer such a scheme.
Let us turn to the questions about sections 77-79 of the Taxation of Chargeable Gains Act 1992. At the time, those sections were introduced as anti-avoidance measures. They were designed to counter tax-avoidance schemes that sheltered individuals’ assets in a trust, so that a lower rate of capital gains tax could be paid. Those sections stop that avoidance, by taxing the trust’s gains on the settlor, at the settlor’s rate of capital gains tax.
With a single rate of capital gains tax of 18 per cent., for both trustees and individuals, trustees cannot get a lower rate of CGT and so there is no reason to retain those anti-avoidance rules. The hon. Member for Fareham also asked about particular trusts that were set up to assist vulnerable people, and that is a useful point for me to respond to.
As a consequence of abolishing those rules, a trust or vulnerable beneficiary will no longer be able to set off any personal losses of the vulnerable beneficiary against gains made by the trustees. However, I inform the Committee that I took advantage of the break to ask HMRC to look into that issue, because I had some concerns based on the representations made. It advised me that capital gains tax does not seem to have been an issue for any of the approximately 500 trusts that have elected into the vulnerable trust regime. That is to be expected. Bearing in mind what such trusts are set up for, we expect that trustees will take a cautious investment approach, which is unlikely to yield significant, if any, capital gains. While I am sympathetic to the point, in practice it does not seem to be an issue. However, if the hon. Gentleman, or any other member of the Committee, has any evidence that this is a problem, I would be happy to consider it further.

Mark Hoban: I thank the Minister for her response to the issue about a trust set up for vulnerable persons. However, the same issue about the application of personal losses against the gains of a trust also applies to a situation in which a settlor has an interest in the trust. That was the other part. I understand why sections 77-79 were introduced in the first place, but the point made by the Law Society is that if they are repealed, a settlor cannot offset his personal losses against those gains.

Jane Kennedy: As I have said, I want to look carefully at this matter to reassure myself that what I have been advised is accurate. I am grateful for the opportunity to discuss that.
Abolishing those sections was in fact originally suggested by representative bodies during the consultations that HMRC held after the pre-Budget report. Abolition was supported by various representative bodies and accountancy firms, including the Institute of Chartered Accountants in England and Wales, the Institute of Chartered Accountants of Scotland, the Chartered Institute of Taxation, the Law Society of Scotland and the Society of Trust and Estate Practitioners. Their view was that the losses issue was a small price to pay for the greater simplification that abolition would bring. As a Government, we were guided by those representations, so I am somewhat surprised to hear the hon. Gentleman say that the Law Society feels differently. We have sought to listen to the representations that we received.
A number of hon. Members, particularly the hon. Member for Fareham, asked about halving relief. It is available where a gain has been deferred, rolled over or held over on the disposal of an asset between 1 April 1982 and 5 April 1988 inclusive, and where the person who made that disposal acquired the asset before 31 March. In such a case, where the computation of a gain on a later occasion has the effect of bringing the deferred gain into charge, only one half of the deferred gain is taken into account in that computation.
Claims for halving relief are rare because the circumstances in which the relief is due are limited. Given that fact and the complexity inherent in applying relief, removing it from the capital gains tax rules seemed a sensible element of the reform and simplification package.
I shall say a bit more about people with share options and entrepreneurs relief, although we will perhaps have an opportunity to explore that further. Shares sold after exercising an option can qualify for entrepreneurs relief if all the qualifying conditions are met, including the 5 per cent. holding test.

Philip Hammond: In an earlier exchange, I asked whether options were eligible for entrepreneurs relief. That is quite a different question from whether shares acquired as a result of exercising options are eligible for relief. One of the qualifying tests is that the shares must have been held for one year and therefore the person exercising the option would have to fund the acquisition of the shares and be able to continue that funding for a year before he could dispose of them and take the benefit of entrepreneurs relief.

Jane Kennedy: Perhaps it is better if we consider that in greater detail shortly when we have made progress on the schedule.
Taper relief was right for its day, but the context was different. Following a decade of macro-economic stability with sustained low levels of inflation, as the hon. Member for Taunton acknowledged in a welcome intervention—on that occasion—it is possible to consider reform and simplification. It might be of interest to the Committee to know that after the pre-Budget report in October last year, someone participating in The Daily Telegraph business blog—a gentleman who is an entrepreneur called Duncan Bannatyne—said:
“I cannot put my hand on my heart and say that a tax of 10 per cent is justifiable when I have employees who pay tax at 40 per cent. I do not believe a tax of 18 per cent will stop anyone from starting a business...For real entrepreneurs...it’s about the pleasure and pride you get from building a company and making it profitable. These are the important factors, not tax gain.”
From conversations I had with those who are described as business angels, particularly in the world of medicine and pharmaceutical investment, I had a similar response.
I shall give one further quote before finishing my comments. In the Evening Standard, on 16 October 2007, Merryn Somerset-Webb commented:
“It’s a good idea on CGT, Alistair—simply do it ... for ordinary people the changes to CGT are brilliant. The old rules were hopelessly confusing. The new ones will be delightfully simple.”
We on the Labour Benches know that one does not normally turn to the Evening Standard to find comments supportive of the Government’s position.

Philip Hammond: I am sure that the person whom the Financial Secretary has just quoted speaks for all second home owners and buy-to-let investors up and down the country, but since she wants to exchange quotes, I will offer her one. I do not have the quote in front of me, but I am pretty sure that at the 1996 Labour party conference the current Prime Minister said that its long-term aim was to have a 10 per cent. rate of tax on long-term capital gains. When introduced, was that an interim measure as well?

Jane Kennedy: As I have said, the capital gains tax regime that was introduced at the end of the 1990s was designed to create a business-friendly environment within the UK that encouraged investment. As I have also explained, over time the support that the taper relief provided to real entrepreneurs and for real business investment gradually began to be eroded. For those reasons, we felt that it was an appropriate time to reform it.

Stewart Hosie: The Financial Secretary quoted Duncan Bannatyne, so I am sure that that is what he said. She also said that the biotech sector had expressed similar views. The BioIndustry Association has certainly said to me:
“Much more needs to be done to help address the potentially fatal blow to the sector dealt by the abolition of taper relief on Capital Gains Tax in order to prevent an exit of investment from the sector, which already faces other significant funding challenges.”
That does not ring true with what the Financial Secretary has just said. I will give her the whole letter later if she has not got it.

Jane Kennedy: I said that in my conversations with those who are described as business angels, they were grateful for the introduction of the entrepreneurs relief. He is right to say that the biotech sector made strong representations, and we responded to them. Again, the same friends that I got to know in my time at the Department of Health said that it was a welcome change and that they were pleased that the Government had listened to the representations that were made.

Jeremy Browne: As I understood Mr. Bannatyne’s quote, he seemed to share the Liberal Democrat position that extremely wealthy hedge fund managers should not be paying a lower marginal rate of tax than the people who cleaned their offices. Is that now the Minister’s position as well?

Jane Kennedy: Mr. Bannatyne did argue that, but he also said:
“I cannot put my hand on my heart and say that a tax of 10 per cent. is justifiable when I have employees who pay tax at 40 per cent.”
That can hardly mean the cleaners in his business. He continued:
“I do not believe a tax of 18 per cent. will stop anyone from starting a business. For real entrepreneurs...It’s about the pleasure and pride you get from building a company and making it profitable. These are the important factors, not tax gain.”
As I have said, we believe that the taper relief was right for its day, but today’s context has changed. We believe that the new regime will be more sustainable and straightforward for taxpayers, with a targeted tax relief to support business investment and enterprise. I therefore hope that the Committee will give the schedule a fair wind.

Mark Hoban: May I say what a pleasure it is to serve under your chairmanship, Mr. Cook. There seem to be new constitutional standards being set, as it appears that blogs can now be prayed in aid to justify a Government tax measure. The comments from Mr. Bannatyne, and the Financial Secretary’s endorsement of them, lead one to question why the Government introduced the taper relief in the first place if all that businesses need is the satisfaction and enjoyment of building themselves up. Clearly, the Government thought that there was a need back in 1998 to set up taper relief. The Minister says that the reason for the abolition is the macro-economic stability over the last 10 years. I am not sure that that is an explanation for the Government’s significant U-turn when they scrapped a relief that was designed in 1988 to encourage long-term investment in economically productive assets. The Government seem to have set themselves against that in these reforms, and the Minister has yet to produce a convincing explanation for that.

Siôn Simon: Will the hon. Gentleman give way?

Mark Hoban: I will not give way, not because I do not welcome the hon. Gentleman’s interventions—his Whip clearly does not welcome them because he waves him down—but because I want to make progress, and we want to move on to entrepreneurs relief.
I do not believe that the Minister has properly addressed the issue. On the abolition of sections 77 to 79, I take note of her comments about the number of representative bodies that supported that abolition, and said that the fact that those losses would not be available to reduce chargeable gains was a small price to pay for abolition. Did the Treasury not investigate whether it was possible to institute those reforms without scrapping that aspect of those sections? When the Minister revisits the issue and addresses the concerns about vulnerable people, she might consider before Report whether there is a way of protecting the use of those losses, consistent with the scrapping of those three sections.
We shall deal with share option schemes later, but I return to the point that, based on the work by ifs ProShare, 250,000 employee shareholders will lose out as a consequence. The measure will affect a minority and not a majority—I have never said that it would affect a majority—but a significant number of people will lose out as a consequence, and they have been ill served, as have others, through the abolition of taper relief.

Question put and agreed to.

Schedule 2, as amended, agreed to.

Clause 7

Entrepreneurs’ relief

Jeremy Browne: I beg to move amendment No. 4, in clause 7, page 3, line 23, at end insert—
‘(2) Within twelve months of the commencement of this section, the Treasury shall compile and lay before the House of Commons a report containing an assessment of the impact of the entrepreneurs’ relief limit on the rate of investment of serial entrepreneurs.’.

Frank Cook: With this it will be convenient to discuss the following amendments: No. 8, in schedule 3, page 124, line 5, leave out ‘£1 million’ and insert ‘the entrepreneurs’ relief limit’.
No. 29, in schedule 3, page 124, line 5, leave out ‘£1 million’ and insert ‘the entrepreneur’s relief limit’.
No. 9, in schedule 3, page 124, line 7, leave out ‘£1 million’ and insert ‘the entrepreneurs’ relief limit’.
No. 30, in schedule 3, page 124, line 7, leave out ‘£1 million’ and insert ‘the entrepreneur’s relief limit’.
No. 32, in schedule 3, page 124, line 49, at end insert—
‘(10) The Treasury shall prepare and publish not later than 31st March 2010 an assessment of the impact of the provisions of subsection (3) on the activity of serial entrepreneurs.’.
No. 10, in schedule 3, page 127, line 27, at end insert—
‘169RA Entrepreneurs’ relief limit
The entrepreneurs’ relief limit is £1 million.
169RB Indexation of the entrepreneurs’ relief limit
(1) This section applies if the retail prices index for the September before the start of a tax year is higher than it was for the previous September.
(2) The entrepreneurs’ relief limit for the tax year is the amount found as follows.
Step 1
Increase the entrepreneurs’ relief limit for the previous tax year by the same percentage as the percentage increase in the retail prices index.
Step 2
If the result of Step 1 is a multiple of £10, it is the entrepreneurs’ relief limit for the tax year.
If the result of Step 1 is not a multiple of £10, round it up to the nearest amount which is a multiple of £10.
That amount is the entrepreneurs’ relief limit for the tax year.’.
No. 31, in schedule 3, page 128, line 13, at end insert—
‘“entrepreneur’s relief limit” means £1 million or such greater sum as the Treasury may from time to time by order specify,’.

Jeremy Browne: As this is the first time I have spoken this afternoon, other than to intervene, may I say what a pleasure it is to serve under your chairmanship again, Mr. Cook? I shall speak briefly because hon. Members may wish to make broader points on clause stand part.
Amendments Nos. 4, 8, 9 and 10 are a response to a number of representations that we have received expressing concern that the Government’s £1 million lifetime limit on entrepreneurs’ relief will discourage investment and reinvestment by serial entrepreneurs in new businesses. My party and, I am sure, many hon. Members in the Committee are keen to encourage entrepreneurship and enterprise, and not to put tax barriers in the way of people creating wealth.
Amendment No. 4 asks the Government to undertake a review of the new proposal to assess the impact on serial entrepreneurs of the measures that they are introducing. Amendments Nos. 8, 9 and 10 refer to a slightly different topic, and would index the £1 million limit. This morning, we discussed how inflation can erode amounts over time, so the amendments suggest a mechanism by which to allow the £1 million to rise in line with inflation, rounded to a practical figure so that it does not become difficult for people to remember.
That would be the effect of our proposals. They are probing amendments, particularly amendment No. 4, to draw out the concerns that have been expressed about the potentially disadvantageous effects of the Government’s measures on serial entrepreneurs.

Philip Hammond: It is a pleasure to serve under your chairmanship, Mr. Cook.
Clause 7 introduces the concept of entrepreneurs relief, about which there will be a fair bit to say as we go through schedule 3. I should perhaps place on record that we remain unconvinced by the Government’s approach of using entrepreneurs relief as a response to the outburst of anger in the business community at both the substance and the manner of the abrupt abandonment of taper relief. However, in the context of our work in the Committee, we will focus on probing some of the more obvious weaknesses in how entrepreneurs relief has been cobbled together.
The approach is clearly modelled on retirement relief, which was a feature of the capital gains taxation system prior to the taper relief system. Retirement relief was causing practical difficulties when it was scrapped. There are concerns that some of the problem areas of retirement relief have been imported to entrepreneurs relief.
The starting point for our approach to the clause and to schedule 3 is that entrepreneurs relief—it is subject to the £1 million cap, which is a big caveat—should seek to restore as much as possible of the beneficial effect of taper relief. Where the Government have tightened up the availability of entrepreneurs relief so that it is more restrictive than taper relief—the case in almost every area—we will want to highlight that, and explore with the Government why they have chosen to do so, apart from the obvious reason that they do not want to spend any money. This was a concession extracted under duress. In particular, and to echo the words of the hon. Member for Taunton, we will want to explore the likely effects of that restrictive application of entrepreneurs relief on the economy.
The context is that taper relief was the Labour party’s great claim to business-friendliness. Whenever anybody asked about the Labour party’s relationship with business, taper relief was wheeled out and waved around as an example of how the party understood and empathised with the aspirations of business people. So the scrapping in the pre-Budget report of taper relief, without any consultation or advance warning, caused a shock wave to run through the business community. A hugely negative signal was sent and huge anger provoked.
The Minister quoted a couple of entrepreneurs who spoke favourably of the process. She could have attended a number of large meetings where she would have heard a vocal view to the contrary. I do not doubt that the measure was popular among the second-home-owning community and the buy-to-let landlord community. However, I think that privately she would acknowledge that the views that she expressed represent a tiny minority among the entrepreneur community, not just because of the material consequences of the change but because of the perception that a signal was being sent that the Government and business were parting ways and that the Government were no longer interested in courting and supporting the business community.
The Government chose to deal with their private equity problem, which they were under pressure, including from the unions, to address. They chose, perhaps chiming with the moves made in the Budget of 2007 in relation to income tax, to send a signal to middle England—to middle-income taxpayers who are typically the second-home-owners and buy-to-let landlords who will be the great beneficiaries of the change. Then, of course, they were forced into a U-turn in response to the united front presented by business. I well remember meetings with the representative business organisations, including the CBI, EEF, Federation of Small Businesses and British Chambers of Commerce. It is extremely unusual for them to be united, but they sat at the same table with exactly the same agendas.
The Government’s introduction of entrepreneurs relief is a cynical response. They have looked at the organisations that led the charge and at how many voters each of them represents and decided to address the problems of the very small businesses—those represented by the Federation of Small Businesses—because it involves lots of voters, including the families and friends of small business people.
We welcome the concessions that have been made in entrepreneurs relief to small, mainly lifestyle, businesses. The move will greatly reduce the impact on many small business people’s retirement funding plans. However, we question whether it is based on sound economics or knee-jerk politics. Contrary to what the Financial Secretary said—I am willing to take her on at any level in any forum on this—the entrepreneurs relief does nothing whatever for serial entrepreneurs. It is a perverse arrangement because, in fact, it rewards those who are moderately successful, but nothing for those who are spectacularly, mind-bogglingly successful in creating high-risk, high-success businesses that go on to create jobs and wealth, and to become the scalable companies that will provide the backbone of the British economy in the next generation.

Emily Thornberry: Is the hon. Gentleman seriously saying that such highly motivated entrepreneurs will give up their work because they will need to pay a higher rate of CGT? Surely the entrepreneurs relief is simply to ensure that small business people are protected so that, when they retire, they will not pay a higher rate. The clue is in the clause title, which is “Entrepreneurs’ relief”, not “Serial entrepreneurs’ relief”, which would mean a completely different group of people. Is he saying that they will stop work?

Philip Hammond: That was an interesting intervention from the hon. Lady. I do not know how much idea she has about how entrepreneurs obtain financing. The problem to which we will repeatedly return is not the hard-working entrepreneur who sets up the small business, but the people to whom they turn to fund their businesses as they go from the first to the next stage of growth. The Minister rightly observed that they will now face an 18 per cent. CGT rate and not a 40 or 10 per cent. rate. The important point that she missed, which the Committee needs to understand, is that the differential of the tax rate on gains from investing in high-risk, illiquid situations, and unquoted businesses at an early stage of growth, and the tax rate on gains from investing in much lower-risk asset classes such as second homes, buy-to-let properties or quoted companies, is precisely zero.
That sends a powerful message to those who we need if we have a dynamic economy. They need to be out there taking risks and losses, which must happen when they make high-risk investments that are trying to scale up. I predict that that is the group of people whose disenchantment with the system will cost the British economy as a result of this change to the taxation regime.

Emily Thornberry: But is this right? I heard today for the first time that the only country in the G7 with a lower rate of CGT is Italy, which is only 0.5 per cent. behind. Compared with our competitors, what disadvantage are we giving ourselves?

Philip Hammond: The hon. Lady completely misses the point. When a potential business angel looks where to invest his money, he looks at the risk he is going to take, the reward he might gain and the taxation on that reward. He does not wonder whether to pop off to Italy and invest in a small business there. He thinks, “Shall I put it in something safer? Shall I buy gold or quoted stocks and shares? Shall I buy a second home or invest in buy-to-let property?” He compares high-risk investments.
We can all make comments about short-term movements in the market, but I hope that the hon. Lady and the Minister will see my point. If we seek—as the Government did, to their credit, with taper relief—to encourage a culture in which people with asset wealth will take large risks by investing that wealth in areas in which some of them will lose money for sure, in the hope of making large rewards and having those rewards taxed favourably, that will deliver an innovative and entrepreneurial culture. Such a culture underpins the growth in wealth and living standards in our economy that the Conservatives aspire to maintain as an essential part of the UK’s economic culture.

Siôn Simon: May I offer the hon. Gentleman a trade from the Back Benches? Some of us on the Back Benches might recognise that there is an element of truth in what he says about there being a perverse incentive, at times, in investment terms, but does he accept that he overstates his case considerably? I take his point, which is fair, but the changes do not mean the end of investment and the death of entrepreneurship in Britain.

Philip Hammond: Now it is the hon. Gentleman who is guilty of overstating his case. I have never suggested that not a further penny will be invested in the UK economy. Clearly, that is not the case. I have spoken to entrepreneurs who have succeeded, and have listened to them explain how their businesses went from being small-scale firms with half a dozen employees and a good idea to the next level, where they were seriously in the game. It is about borrowing money from family and friends, and cobbling together networks of informal investors.
To give the Government credit, taper relief has played a huge role in giving people an incentive to invest, including people who might never have invested before, and certainly people who do not think of themselves as private equity investors. It has encouraged such people to take risks by investing in someone whom they know or in a local business enterprise such as a new restaurant or a factory where a new widget that has been invented is to be made. It has been very successful and has helped to create an entrepreneurial culture in this country that has helped our economy hugely in the past few years. We should be extremely proud in this country, as I am, that we have—until now—had a more innovative business culture than any other nation outside the United States that I can think of. I genuinely fear that we are putting that at risk.
We could argue all day about whether I am exaggerating the case. Indeed, I hope that I am and that history will prove me wrong, but I fear that it will not. Obviously, we will have to wait and see what happens. The Conservatives’ intention this afternoon is to probe the Government not on the principle of entrepreneurs relief—I have said my piece on that—but on the details. It is restrictive, but let us see whether there are areas in which it is too restrictive or more restrictive than the Government intended. Let us see whether it could be made less restrictive in order to apply it to areas in which the hon. Members for Birmingham, Erdington or for Islington, South and Finsbury might think that it applies, but in which we might discover, when we look closely at the fine print of the measure, that it does not.

Clive Efford: The hon. Gentleman has been fulsome in his praise of the previous Chancellor, the current Prime Minister, for introducing taper relief, and about its success in creating entrepreneurs. Will he remind us what the Conservatives’ position was regarding the Budget that introduced taper relief?

Philip Hammond: No, I will not because I cannot remember, but I am sure that the hon. Gentleman will.

Clive Efford: Shall I remind the hon. Gentleman?

Philip Hammond: I am sure that he will.
I will return to the amendments in hand. Amendment No. 4, tabled by the Liberal Democrats, and amendment No. 32, which I tabled, focus on the risk of damaging the incentives to serial entrepreneurs. As I have already said, serial entrepreneurs are the lifeblood of an innovative economy. They take risks and establish businesses, which, if successful are floated or absorbed by larger players in the sector. It is often easier to innovate in a new, small business. It is often safer for larger companies to acquire proven, established new technologies that have been got to that first stage of development, rather than try to develop them themselves in their own rather more bureaucratic environments. Whether they are establishing new technologies, ideas or marketing approaches, small, innovative companies established with the intention of growth are the lifeblood of our economy. They are the oxygen that feeds it with new ideas and new processes. They are also mobile because they are essentially based on talented individuals.
Before the hon. Member for Birmingham, Erdington jumps up and accuses me of exaggerating, I am not suggesting that no entrepreneur will ever open a factory in Britain again or that they will all desert. However, it is noticeable to those of us who have had discussions since the pre-Budget report with groups representing entrepreneurs that a significant minority intend to exercise their mobility. Some of those people do not originate from the UK, but are foreigners who came here because the economic climate was attractive. My hon. Friend the Member for Tatton (Mr. Osborne) and I spoke to a Canadian who had established either two or three successful businesses, all of which had been sold. He intended to return immediately to Canada to establish his next venture.

Peter Bone: My experience of building up a new innovative company is that we had the support of the Americans. They look round to see which is the best country for entrepreneurs. It is the signals that we send to such people that are important. Those signals are as much as anything about the practicalities. We want to capture those people and get them here.

Philip Hammond: My hon. Friend is right. It is not just about the money. It is about the signals. Taper relief sent a signal that entrepreneurs were valued. I am not making a party political point, but there was a time in the history of the Labour party when those who created wealth and made huge profits were denigrated. It was hugely reassuring to potential entrepreneurs to see the party that had traditionally denigrated wealth creation celebrating it. That sent a very powerful message. The pre-Budget report last autumn reversed that message in double-quick time. As my hon. Friend says, that is part of the problem.
I have made my point already about the 18 per cent. rate. The point is not whether it is competitive with other jurisdictions, but whether it is competitive against less risky forms of investment within this jurisdiction. There is a very real concern about the signal that is being sent.
We share with the Liberal Democrats the concern about the impact that this measure will have. As the hon. Member for Taunton said, the proposal to require a report is simply a probing device to address these issues with the Government. The Government will no doubt say that they will monitor carefully what happens and that they will look closely at the behaviour of entrepreneurs. I say to the Financial Secretary that at the level of Government, she will detect the problem only long after it has occurred. These people are invisible until they come to realise their gains. They are not registered on any HMRC database or picked up by any Government questionnaire. They are going about their daily business quietly all over the country. The investment networks are highly informal—investors clubs, informal networks within neighbourhoods and between family and friends. She will discover that there is a problem only two, three or four years down the line when it has already occurred and the system of financial support for entrepreneurs is broken. That is our concern, and that is why we seek to place in the Bill a requirement to assess the effect of increasing the tax rate from 10 per cent. to 18 per cent. for all but the smallest companies. In particular, that will mean looking at the effect on serial entrepreneurs and business angels. Such a report would inform potential future changes of policy by a future Government, and it would be good to have it under way and presented in good time.
Taper relief was not perfect; no one would suggest that. Clearly, some of the flaws in it, particularly in relation to its use in private equity, had been extensively identified and debated and could have been addressed without removing the entire system. We could have had a system that addressed those problems but left a recognition of genuine medium-term entrepreneurial success.
The Opposition will now want to look again at the whole system of business capital taxation. In the meantime, it is essential that we monitor the effect of, what I must say is a very silly, short-term and economically inept move. Amendments Nos. 4 and 32 have the same purpose. If the hon. Member for Taunton decides to press his amendment to a Division, my hon. Friends and I will be happy to support him.
The remaining amendments in the group address the level of entrepreneurs relief. We have the same intentions as the Liberal Democrats—that of probing the Government’s intentions. There is no mechanism for indexing the relief. I know that £1 million is a temptingly round number, but it would be sensible to send some form of signal about the Government’s future intentions. The Liberal Democrats have chosen to index it by the formula used to index allowances and thresholds. We have taken a slightly different approach and provided for the Treasury to vary the £1 million limit by order, so that it can be done as quickly as necessary. We think that that is just as good, but we would not fall out with the hon. Member for Taunton over that point.
The point is this. If my predictions, and those of other hon. Members on this side of the Committee, are right; if the niggling and the just about concern of the hon. Member for Birmingham, Erdington turns out to be for real—none of us know hether it will —the Government must be able to respond quickly. If we find that hon. Members of all parties are picking up signs from talking to people in their communities, professional accountancy firms, lawyers and so on that the system is breaking down, the Government must be able to respond. They should not necessarily wait for the next Finance Bill to go through Parliament, and the power to vary the limit by order would be a worthwhile weapon in their armoury. Rather unusually, I find myself arguing in favour of greater power for the Government to intervene without the need for primary legislation, because I feel that in this case, the need to act very quickly may arise.

Jane Kennedy: As we have been discussing, clause 7 introduces schedule 3, which contains the provisions related to the proposed capital gains tax entrepreneurs relief. Broadly speaking, the relief is available on the disposal of a trading business, or shares in a trading company, provided that the person making the disposal is an officer or employee of the company and has a minimum 5 per cent. stake in the business. The relief reduces the effective capital gains tax rate from 18 per cent. to 10 per cent. for up to the first £1 million of qualifying gains made over a lifetime.
Those conditions are designed to help focus the relief on individuals who play an active role in a business, and have a material capital stake in that business. The £1 million lifetime limit for the relief strikes a balance between providing flexibility for individuals and ensuring that valuable tax reliefs are targeted in a fair and efficient manner. We recognise that in some cases investors may not meet those criteria. However, we believe that the rules that we have announced are a reasonable way to determine eligibility for the new relief.
We estimate that around 80,000 business owners and investors will benefit from entrepreneurs relief next year alone; 90 per cent. of that group will pay capital gains tax at an effective rate of 10 per cent. on their entire gain. That includes people who are selling their business and retiring, who will continue to benefit from a 10 per cent. rate on the first £1 million of gains, and 18 per cent. on the excess over £1 million. The Government consider that a limit on relief for the first £1 million strikes the right balance between supporting entrepreneurs and taking a fair amount of tax from people with large capital gains. Even where gains exceed the £1 million limit, the individual will keep 82 per cent. of whatever gains they make, which remains highly competitive, as I argued earlier.

Philip Hammond: The hon. Lady said that the Government estimate that 80,000 people will benefit in the first year alone from entrepreneurs’ relief. To put that into context, can she tell the Committee how many people benefited from taper relief in the last year for which it was available? If she does not have the answer, could she perhaps obtain it and advise the Committee later so that we can understand the context of her remarks?

Jane Kennedy: I will give that figure if I can before I sit down, but if not, I shall happily provide it to the hon. Gentleman and members of the Committee in writing. I have some further figures that I think will interest the Committee, which set some of the context.

Peter Viggers: May I ask the Minister about a matter that was raised with me by the Chartered Institute of Taxation? It is concerned:
“that the entrepreneurs’ relief does not appear to be available for:
Certain assets used in a business, such as a property owned outside a trading company and rented to that company - even where the company stops paying rent from April 2008;
Most employee shareholdings - where not an owner manager. This seems to be a reversal of policy encouraging employee shareholdings.”
I recognise that those are technical points that I have raised late, but if it is not possible to answer them immediately, I would be grateful if they could be dealt with in some way.

Jane Kennedy: I will obviously seek to respond. We discussed employee share schemes in the earlier debate—I think that the hon. Gentleman was present. If they were not covered then, I shall seek to answer the points that he quite properly raises. There is no need for an order to increase the £1 million limit. If an immediate increase were desirable, it could be announced with immediate effect and then included in the Finance Bill. However, I will come to that in greater detail in a moment.
The hon. Member for Runnymede and Weybridge argued that the Government were failing to support risk-taking in business investment. We believe that the new regime makes it easier to understand the capital gains tax position. Being able to understand tax liabilities is helpful to businesses considering investment. A number of sources of relief remain to support risk-taking and enterprise: losses can be offset against future capital gains; business asset rollover relief means that gains can be reinvested and tax deferred; venture capital trusts, which I shall return to in a moment, and enterprise investment schemes also continue and have been enhanced. Entrepreneurs relief is focused on people with a material stake in a business. 
The hon. Member for Dundee, East asked questions in the previous debate about share options as opposed to shares. The relief is focused on people with an actual material stake. That means people who own businesses or company shares. It is not available on options themselves. However, if the options are exercised and shares are required, relief will be given if the conditions under schedule 3 are met.

Stewart Hosie: If I understand that correctly, the person would have to crystallise the option, purchase the shares at the price and hold them for at least one year in order to benefit, irrespective of for how long they had held the options. Is that so?

Jane Kennedy: I understand that to be the case. Because the matter has generated some interest in the Committee, I will check to make sure that what I have said to hon. Members is accurate. I believe that it is.
The group of amendments considers both the impact of the entrepreneurs relief on serial entrepreneurs and the £1 million lifetime limit for access to relief. Amendments Nos. 4 and 32 would require the Treasury to report on the impact of the new entrepreneurs relief on serial entrepreneurs and to do so within the next year or two. Neither amendment is necessary. As with any new aspect of the tax regime, we will keep the operation of the new entrepreneurs relief under review as a matter of course. I accept that that form of words is used regularly. but, because of the importance of the relief to Britain and British business, we will want to be sure that the arrangements that we have put in place will do exactly what we hope. On a practical level, requiring the Treasury to report back within a one or two-year window is not a realistic time in which to evaluate the long-term impact of a policy change properly.
Amendments Nos. 8 to 10 deal with the £1 million lifetime limit, and would introduce an automatic annual uprating in line with the retail prices index. Amendments Nos. 29 to 31 would introduce a power to alter the limit by a Treasury order. I am quite interested in that proposal, particularly as it comes from the hon. Member for Runnymede and Weybridge. Again, the amendments are unnecessary. The Government have said that the £1 million lifetime limit will be kept under review. We will follow through on that commitment accordingly. If and when the time comes to alter the limit, it will be done in a future Finance Bill but, if necessary, we have powers to do it anyway with the opportunity for Parliament, under the Finance Bill, to debate the matter further.
I want to say a further sentence or two about our commitment to monitor the relief and how it is working. My hon. Friend the Member for Birmingham, Erdington is right that we heard the concerns that were expressed following the PBR, which is why we introduced the relief. It was welcome, but clearly we shall want to monitor its impact. That is not just the usual thing that Ministers say to get over a point. In this case, it is important to us to do so.
The Committee would be interested to know that the number of small and medium enterprises has risen by an estimated 17.2 per cent. since 1997. There are now 4.3 million small and medium enterprises in the United Kingdom, which is 99.9 per cent. of all UK businesses, employing 58.5 per cent. of the private sector work force and generating more than £1,000 billion of private sector turnover.

Greg Hands: The Financial Secretary is being a little backward-looking. What about the relative attraction of different asset classes? If we want to attract entrepreneurs, we should do something to make putting capital in such a venture more attractive than putting it in a FTSE 100 company. Looking forward, how does the right hon. Lady believe that the measures will allow that?

Jane Kennedy: I am giving figures to the Committee to show the health of the business sector.

Greg Hands: In the past.

Jane Kennedy: Well, those figures are reliable and in the public domain, and are worthy of drawing to the Committee’s attention. The enterprise investment scheme, for example, has raised more than £5.5 billion since its inception, and invested in more than 13,000 smaller high-risk companies. That scheme remains in place and the venture capital trusts have invested more than £3 billion in more than 1,400 companies. That is also supported and encouraged by the Government. As I have said before, the 23,000 claims for R and D tax credits—20,000 of them made under the small and medium enterprise scheme—made since the scheme’s introduction in 2000 are encouraging indications that the UK remains a competitive economy in which businesses are encouraged to invest.

Philip Hammond: As the Financial Secretary has touched on the number of small company incorporations and quoted it again, may I ask again a question which I asked her, or perhaps it was her colleague, during a debate in the House a couple of weeks ago and which was not answered then? Yes, the number of incorporations has increased, largely driven by tax incentives to incorporate, but is not the figure about which she should be concerned the fall in the number of companies reaching £1 million turnover within three years? So we have more companies and more lifestyle businesses being incorporated—whether that is a good thing is not an issue. The key thing is that we are not getting them to that critical £1 million turnover level from which they can grow and become generators of employment and real wealth in the economy.

Jane Kennedy: Such figures are precisely why we want to keep the entrepreneurs relief under review. We have discussed the state of the economy, and it would not be wise of me to do so today, but we believe that there is a still a great deal of healthy indication in the figures. I will want to look at the point that he has raised. He asked me to set the context by saying how many people benefited from taper relief, but I do not have that figure immediately available. I will write to him.

Siôn Simon: May I make a suggestion? To some extent, this move looks slightly counterintuitive and at the more micro-level the enterprise investment scheme is under quite a lot of pressure. Perhaps the Treasury could have another look at how it could give more support to that. The R and D tax credits, for instance, are not available to wholly private equity-funded companies because of the control roles. Given that the Treasury is going to do this rather counterintuitive thing, it should have a serious, across-the-board look at how it can support investment in businesses with a turnover below £1 million, which are so crucial in areas like the west midlands and the north-west.

Jane Kennedy: I know that my hon. Friend takes a keen interest in the regime within which we encourage businesses to invest and grow. He makes a sensible point, and I am happy to take it on board. It ought to form part of the ongoing review that we make of the alterations that we have made to this reform. It is a very big reform. We believe that it will have an enormous benefit by introducing simplification into an otherwise extremely complicated area. I will be happy to undertake the work that he suggests.
I hope that, having heard my remarks, the hon. Member for Taunton—

Philip Hammond: Will the Financial Secretary give way?

Jane Kennedy: I am just about to finish.

Philip Hammond: I am grateful to the right hon. Lady for being generous enough to give way. That will save me from rising again to make a further remark.
The right hon. Lady said in response to the proposals in the amendments that the Government had the power to alter the £1 million level, and that they would keep matters under review. That may well be the case; I do not dispute that. However, both the hon. Member for Taunton and I said that this was a probing amendment. We hoped to get from the Financial Secretary a clear signal to entrepreneurs as to the Government’s intentions regarding the £1 million limit. If there is not an utter disaster and it needs to be trebled, and if it is not a raging success and 500,000 people claim it in the first year, but if it just ticks along normally, what are entrepreneurs to understand? Is it expected to increase in line with inflation? This was a concession grudgingly made after the pre-Budget report. The Government, even the right hon. Lady with her best hat on, will not be able to pretend that it was part of the original plan. It is necessary to send a signal that, although grudgingly made, it will not be allowed to wither on the vine but will be uprated in line with inflation.

Jane Kennedy: We were convinced by the representations made following the pre-Budget report of the need to assist entrepreneurs and investors. That is why we introduced the relief. If the relief does its job, we will want to keep the limit. We will keep the limit under review. I cannot give the hon. Gentleman an absolute commitment that we will set an automatic revision rate, or a time at which we would further consider the limit. However, we look at all taxes as we go through the normal processes of considering policy, through the pre-Budget report programme of work and in preparing for future Budgets. Therefore, I cannot give him an absolute guarantee that we will always raise the rate in line with inflation or at a particular time, but we will keep it actively under review. We are keen to ensure that it is working and encouraging investment as we have described and as we expect.
I therefore hope that I have persuaded the hon. Member for Taunton to withdraw the amendment, in the spirit of probing amendments. I hope that, if he does not, the Committee will resist it.

Jeremy Browne: This concession, the entrepreneurs relief, is a model of how the Government, and the Treasury in particular, should not conduct their affairs. It came, of course, after the main event, as a concession made when the Government realised that they had made a serious miscalculation and thus sought to adjust the policy to diffuse the frustration, anger even, in many parts of the business community. However, I will readily concede that this is not an issue that the average member of the public detains himself or herself with on a daily basis. There is unlikely to be a public clamour for the Government to uprate entrepreneurs relief in line with inflation or any other measure, in the way there is on the doubling of the 10p rate.
The fear that I—and I suspect many people who are entrepreneurially minded in the business sector—have is that the mechanism has bought off anger and frustration in the short term and may be allowed to wither on the vine. The Financial Secretary, in rejecting both the Conservative proposal and the less flexible but more specific proposal in the amendment tabled by me and my hon. Friends, did not rule out cutting the £1 million figure at some point, were it to prove too expensive to the Treasury. One million pounds is a suspiciously round number, and many of the general public might be persuaded that that is a large enough amount of money for nobody to worry too much about whether it needs to go up in line with inflation or the overall growth of the economy. In addition to that, she showed some uncertainty when she rose to defend the policy, and kept saying that the Government would keep it under review. That made it sound as though it was a policy built on shifting sands. That reinforces all the more our inclination to pin the Government to something more specific, certainly a meaningful Treasury review of the impact of the proposal. Many who take a close interest in these matters, and will read our deliberations at a later date or even later today, will be keen that Opposition parties hold the Government to account on this matter. For that reason, I am keen to push amendment No. 4 to a vote.

Question put, That the amendment be made:—

The Committee divided: Ayes 11, Noes 16.

Question accordingly negatived.

Question proposed, That the clause stand part of the Bill.

Philip Hammond: I would just like to say a few words before we agree this clause, which introduces schedule 3. I hate to say this to the Minister, but I detect a degree of complacency in her remarks. I honestly do not think that Ministers understand what they have done; perhaps Labour Members have a better idea. I say that openly. If we on the Conservative Benches had wanted to devise a strategy for the Government that would help us in securing the maximum number of business voters for the Conservative cause, we could scarcely have done better than to ask them to abolish capital gains tax taper relief without consultation or warning. It created an anger in the business community that I do not think anybody can remember the like of.
The Minister said that the entrepreneurs relief had been welcomed. If she thinks back, she will remember that it was welcomed by the Federation of Small Businesses, quite properly representing the smallest scale of businesses—those that are most likely to benefit from it. The CBI, the Engineering Employers’ Federation and the representatives of larger-scale businesses, which are so important to the economy, described it as wholly inadequate. It is the economic consequences that we are particularly concerned about.
It is a hastily cobbled together measure and before the Committee agrees clause 7 it needs to think one more time about this. In order to mitigate the damaging effects of the abolition—

Frank Cook: Order. If this is a rerun of discussions that have already taken place, I hope that it will not go on for too long.

Philip Hammond: Mr. Cook, I would not dream of rerunning a discussion that has already gone on and I shall not go on for very much longer. I merely want to ensure that before members of the Committee—particularly Labour Members—take this step, they consider the politically damaging effect of abolishing what was Labour’s flagship pro-business policy.
If any Labour Members are wondering why the anger of low-income earners who were hit by the abolition of the 10p rate has been mirrored by the anger of business owners who are hit by the abolition of the 10p long-term capital gains tax rate, I say to them that it is for the same reasons in both cases. Those were both long-term Labour objectives. Both were introduced with great fanfare. Both were trailed as symbols of Labour’s commitment on the one hand to those on low incomes and on the other to long-term investors. Both were withdrawn without warning or consultation for cynical political reasons and both represent a denial of the Prime Minister’s statement that when the Government make promises, they keep them. For those reasons, they have incurred the wrath of the business community, the low paid and all who believe that our tax system should be fair and balanced. I urge Labour Members to think very carefully before agreeing to the clause.

Jane Kennedy: I have been provoked and I promise that I will respond very briefly, Mr. Cook. I feel that it is necessary to defend the Government’s proposals. When I say that I will keep the matter under active review, I am accused of complacency. I understand that the Conservative party is reviewing its manufacturing strategy and has embedded some of its policy staff in Rolls-Royce to understand some of the issues that that company faces. These criticisms are a bit rich when, on two occasions that the Conservatives were in control of the economy and had an effect on the way that businesses made decisions, interest rates hit 15 per cent. and 3 million people were unemployed.

Hon. Members: Hear, hear.

Jane Kennedy: I think that we have an entirely defensible position and I encourage my hon. Friends to support the Government proposals.

Hon. Members: Hear, hear.

Frank Cook: We seem to be getting more echoes than one would receive in the Pyrenees.

Question put and agreed to.

Clause 7 ordered to stand part of the Bill.

Frank Cook: At this stage, I feel obliged to make an observation. Throughout this week, on Tuesday in Westminster Hall and in Committee and again today, I have witnessed a number of minor transgressions against what have been considered time-honoured practices in the House, both in the main Chamber and in Committee. When a right hon. or hon. Member is addressing the Chamber through the Chair or speaking directly through the Chair to another hon. Member, it is considered bad form and to be discouraged if hon. Members cross the direct line of address between the Member and the Chair, between the two Members or in passing messages.
I simply ask members of the Committee to remember protocols and to behave as civilised Members of the House should. You are all time-served now and fairly well seasoned in these practices. Even the youngest of you in parliamentary terms have been here since 2005. I thank you for the attention. I also ask the Financial Secretary, particularly when addressing her own side, to bear in mind that I am partly deaf—not daft, deaf. She speaks very quietly, which I applaud, but only if I can hear and understand her, because part of my job is to understand every syllable.

Schedule 3

Entrepreneurs’ relief

Philip Hammond: I beg to move amendment No. 14, in schedule 3, page 120, line 20, leave out from ‘use’ to ‘for’ in line 21.

Frank Cook: With this it will be convenient to discuss the following amendments: No. 15, in schedule 3, page 120, line 22, after ‘business’, insert
‘where such assets have been in such use for a period of not less than two years at the time of the disposal’.
No. 17, in schedule 3, page 120, line 26, leave out from ‘throughout’ to first ‘the’ in line 27 and insert
‘a 12-month period beginning not more than two years before’.
No. 18, in schedule 3, page 120, line 30, leave out from ‘throughout’ to first ‘the’ in line 31 and insert
‘a 12-month period beginning not more than two years before’.
No. 16, in schedule 3, page 120, line 31, leave out from ‘which’ to end of line 34 and insert
‘the disposal of the asset takes place’.
No. 19, in schedule 3, page 120, line 37, leave out from ‘throughout’ to second ‘the’ and insert
‘a 12-month period beginning not more than two years before’.
No. 23, in schedule 3, page 120, line 41, leave out from ‘group’ to end of line 44.
No. 24, in schedule 3, page 121, line 1, leave out from ‘the’ to end and insert ‘condition in’.
No. 25, in schedule 3, page 121, line 2, leave out ‘are’ and insert ‘is’.
No. 20, in schedule 3, page 121, line 2, leave out from ‘throughout’ to end and insert
‘a 12-month period beginning not more than two years before’.

Philip Hammond: Schedule 3 is one of the critical measures of the Bill. It is very complex, contains lots of technical issues and is lengthy. There will be a series of debates about it and inevitably there will be some overlap between issues that arise in one debate and those that arise in another. If I may, bearing in mind your reluctance to allow a stand part debate in relation to the previous clause, Mr. Cook, perhaps I could just say this—

Frank Cook: Correction. I cannot allow that to go unchallenged on the record. I allowed the hon. Gentleman to make the points, almost ad nauseum, that he had already made on the amendments, so there was a stand part debate, a response to it, and it was put to a vote, so let us have the record straight, please.

Philip Hammond: Okay, and the record will record the phrase “ad nauseum” as well, Mr. Cook. I apologise if I erred, but I gained the impression that there was an element of reluctance. That is my error.
I was seeking to make the point that a large number of amendments have been tabled to the schedule and a large number of outside bodies have raised further issues with it—all members of the Committee will be aware of that because they will have received the briefings. A number of issues have not been covered by the amendments tabled so far, because the observations from professional outside bodies arrived too late for amendments to be tabled. It might be possible, depending on the progress of today’s debate, for further amendments to be tabled. If it is not, it would be helpful to the Committee if we were able to cover some of the areas raised by the Law Society, in particular, in a stand part debate at the end. My point is that I will resist the temptation to go wider than the amendments to try to sweep up some of the other issues in the hope that we will be able to come to them in a stand part debate.

Frank Cook: Eminently sensible.

Philip Hammond: Thank you, Mr. Cook.
This large group of amendments deals with the scope of disposals eligible for entrepreneurs relief. As we have already said—perhaps ad nauseum—it is much narrower than the scope of taper relief. In principle, we are seeking to establish why the scope of taper relief is not being applied within the £1 million limit that the entrepreneurs relief regime proposes. All the amendments in the group relate to new section 169I. As the Committee will understand, schedule 3 inserts a number of new sections into the Taxation of Chargeable Gains Act 1992, so the structure of the schedule is a series of new sections to that Act. Section 169I deals with the disposal of shares or of assets used in an unincorporated business.
Three separate issues are raised by the amendments. Amendments Nos. 14, 15 and 16 seek to redefine a disposal of business assets under new section 169I(2)(b), which deals with the disposal of assets that are used for the business but that are not owned by it. An example would be the disposal of a factory building at the time the business operating that building is closed down. There may be various circumstances in which that structure is used in the financing of a small business, and where the individuals involved may personally own assets that are deployed in that business. That may be because there is difficulty in raising capital for the business, or because capital can be raised only by giving personal guarantees or security over personal property—typically residential property—and it is thought to be safer for the individual to own the asset personally and allow it to be used in the business. The subsection seeks to deal with the situation where an asset is disposed of at the same time as the disposal of the business.
As drafted, the Bill only allows eligibility for entrepreneurs relief in the disposal of an asset used in a business, if that business ceases to be carried on by the individual. The broader issue is the contrast between the treatment of sole traders—individuals who carry on businesses—and the treatment of partnerships. As many of the professional bodies have pointed out, one of the effects of picking up the old retirement relief regime and using it as the skeleton for the model of entrepreneurs relief, is that it does not seem well fitted to the world of limited liability partnerships as a new business form that is becoming increasingly used. Because of that, we have a situation where partners in limited liability partnerships will receive different treatment from individuals who are sole traders. By virtue of new section 169I(8), assets disposed of by partnerships where the business does not cease to be carried on, will be eligible for entrepreneurs relief. That seems somewhat iniquitous. If someone sells a factory while continuing the business, they will have no eligibility for entrepreneurs relief in respect of the gain on the sale of the factory.
Once again, that is economic nonsense. It discourages people from renewing assets and it encourages them to hold on to assets used in conjunction with the business until such time as the business is disposed of. They do that rather than renewing those assets on a timely basis that is dictated by normal economic considerations rather than driven by tax considerations. That is generally not the best way to plan and run a business and, from the point of view of the economy, it is not the way to achieve the optimum outcome.
The amendments seek to inject into the structure of the Bill the characteristics of the taper relief regime, where all disposals of business assets were eligible. That was one of the key characteristics of the taper relief regime as far as smaller businesses were concerned, and it was very helpful to them. The amendment deletes the words on page 120, line 20, so that there would be no reference to the business ceasing. Instead, it inserts a requirement for the asset to have been in use for the purposes of the business for at least two years at the date of disposal. Two years was picked to represent what would have been the qualifying period for full taper relief under the previous taper relief regime.
The Government’s drafting creates what I would call an artificial concept of ceasing the business as a qualification. We will return to the question of what cessation of carrying on the business actually means—it is very woolly drafting and we will come back to it in about 300 amendments’ time. It is a term borrowed from the retirement relief legislation, where there was clearly an unambiguous intention that retirement was to take place. Reading this schedule, it is not clear whether there is an intention for retirement to take place. In some places it looks as though that is what is in the draftsman’s mind, and in other places it looks as though that interpretation has been modified. There is a lack of clarity about what is intended. Given the lifetime cap of £1 million, we suggest that there is no need for the restriction on the disposal of assets used in a business at any time as it would simply mean that somebody got to their lifetime cap more quickly. By introducing that additional hurdle, the Government are creating a complex and potentially damaging restriction that could actually be removed without any significant consequences. That is what amendments Nos. 14 and 15 address; amendment No. 16 is purely consequential.
Each of these little clusters or sub-groups of amendments stand separately. What I am about to say in relation to amendments Nos. 17 to 20 does not assume that amendments Nos. 14, 15 and 16 have been accepted. Amendments Nos. 17 to 20 assume as their context the continuation of a requirement for cessation of involvement in the business and they relate to the restriction concerning the time of ownership of the business. The amendments come principally from the Institute of Chartered Accountants in England and Wales, although others have made similar observations. Nobody has any problem with the one-year period of ownership, but as the current wording of the Bill is restrictive it is suggested that the qualifying period should be defined in the same way as the qualifying period for the substantial shareholding exemption—any 12-month period in the previous 24 months.
The amendment paper contains four identical amendments and I have explained the concept behind them. On reflection, substituting
“a 12 month period beginning not more than two years before”
for the words in the Bill, which refer to a period of one year ending with the date of disposal, does not have any material effect and is arguably unworkable in relation to new sections 169I(3) and (4). I accept, before the Minister gets there, that amendments Nos. 17 and 18 are inappropriate. In other words, the suggested changes have been inserted in four places where they should have been inserted only in two places. Amendments Nos. 19 and 20 are the substantive proposals that I want to speak to and I will accept a slap on the wrist in respect of amendments Nos. 17 and 18.
Amendments Nos. 19 and 20 would create greater flexibility around the time at which it is necessary for an individual to comply with the requirements, first, to own 5 per cent. of the shares in the company and, secondly, to be an officer or employee of the company. Amendment No. 19 would allow a qualification for entrepreneurs relief where the shareholding fell below 5 per cent. at the point of disposal, or where the individual ceased to be an employee or officer of the company, so long as he held the 5 per cent. and was an officer or employee for a period of 12 months in the last 24 months.
That aims to give some flexibility to accommodate real-world scenarios of managed exits from small businesses. It is quite possible, for example, that the exit of an individual from a business might involve a structured reduction in his holding, such that he disposed of some of his shares, leaving him with 2.5 or 3 per cent. at one point in the process, and he then disposed of the remainder at his final exit. It is also likely that he may cease to be an employee or officer of the company before finally disposing of his shareholding. The tax regime in the Bill will drive structures for exits from businesses and that is undesirable. We think that the tax regime should not drive behaviour that otherwise would optimise the smooth transition of a business from one ownership to another.

Mark Field: I rise briefly to clarify my hon. Friend’s comments. Would the 12-month period out of the previous 24 months have to be unbroken to avoid the sleight of hand and other concerns that he has rightly raised about the tax tail wagging the corporate dog?

Philip Hammond: My hon. Friend raises a good point. The intention, as I said earlier, is to replicate the requirements of the substantial shareholding exemption. My understanding is that that requires an unbroken 12-month period beginning not earlier than the period of 24 months from the date of the disposal in question.
Amendment No. 20 allows the same flexibility around the timing of the qualifying period where a company has ceased to be a trading company prior to disposal. That will quite often happen, such as when a business is being run down and is being turned into a cash and asset-holding shell and the balance between the holding of assets and the trading activity becomes such that the company is no longer treated as a trading company by HMRC. That is not an atypical situation in the winding up of a small business when someone is seeking to retire.
Subsection (7) of the new section signals that the draftsman understood that sometimes an exit will be structured so as to wind a business down and turn it into a non-trading shell, but did not understand the possibility of a managed exit by the individual, where the company will continue trading as he reduces and finally relinquishes his shareholding and at some point ceases to hold office. Our challenge to the Government is whether these arrangements are economically sensible and whether they encourage a degree of tax planning in the management of small businesses which will be detrimental to the most efficient functioning of those businesses and thus of the economy overall.
Amendments Nos. 23 to 25 address a slightly different issue. Amendment No. 23 challenges the requirement for an individual to be an officer or an employee of the company in question. That was not a requirement under the taper relief regime and it is not obvious why that requirement has been inserted now. The Minister earlier said that the relief was targeted at owner-managers: I think she used that phrase, but she certainly talked about active involvement. I urge the Government not to slip back into the pre-1994 Labour party thinking that only the people who work on the shop floor are contributing. The investors who risk their capital are also a vital part of the equation.
The Minister may say that that is not a problem because it is perfectly possible for the business angel investor to become a director of the company. Then he will qualify, but more and more responsibilities and liabilities are being placed on directors of companies, for example, in relation to health and safety with corporate manslaughter provisions coming in. We should not encourage phantom directorships where for tax purposes people who have no control or involvement in the day-to-day running of a business become directors simply so that they qualify for a certain tax treatment. That would be a detrimental move. We should aim for an environment in which the directors of a company are the people who are in control of that business and can therefore be properly held to account for the conduct of that business on a day-to-day basis. That requirement will encourage people who are not actively involved in the business to seek nominal directorships, while having no engagement in the running of the business. I would be interested to hear the Minister’s take on that scenario and whether she believes that there is an issue of concern there. That concludes the group of amendments. Amendments Nos. 24 and 25 are consequential to amendment No. 23.

Jane Kennedy: I will take on board your comments, Mr. Cook, about the volume of my speech. You will be pleased to hear that you are in good company. The first time I spoke in a Standing Committee—on the National Lottery Bill—our dear hon. Friend Gwyneth Dunwoody was in the Chair. Within my first three sentences she had leaned across the lectern and, as only she could do, whispered loud enough for the whole of the Committee to hear, “For goodness sake, Jane, speak up”. I hear what you say and I will do my best to remember it.
Under the taper relief rules, business asset taper relief was potentially available on the disposal of any business assets, provided that there was a qualifying period of ownership of at least one year. Entrepreneurs relief, on the other hand, is available where disposal of assets is part of the disposal of all or part of the business, or where disposal takes place of assets used up to the time the business ceased. I confess that I missed which of his amendments the hon. Gentleman felt were unnecessary, but I heard him say that amendments Nos. 19 and 20 were the two key amendments.

Philip Hammond: Amendments Nos. 17 and 18.

Jane Kennedy: Amendments Nos. 17 and 18. Some business asset taper relief was available in respect of disposals of shares, if the company had been a trading company or a holding company of a trading group at any time in the 10 years preceding the disposal. Entrepreneurs relief is available only if conditions are satisfied throughout the year immediately preceding the disposal, or the cessation of the company’s business, if earlier.
I will take first one of the last points that the hon. Gentleman made. He invited us to consider seriously whether it is sensible to create what he believed might be described as phantom directorships for tax purposes. That is not a partisan point; it is a sensible point and I will consider whether that is one of the matters arising from this set of reforms that we need to keep closely under review. We will listen to representations on that point.
The differences that I have described between the taper relief rules and those for entrepreneurs relief mean that entrepreneurs relief is not available on many disposals that would have qualified for taper relief. That is an effect of the different targeting of the two reliefs. The effect of amendments Nos. 14 to 16 would be that an asset that had been used for business purposes for two years would qualify for entrepreneurs relief, without the requirement that it be a disposal on cessation of business.
Amendments Nos. 17 to 20 would make it possible for assets that had changed use before disposal to be eligible for entrepreneurs relief, and shares could qualify even if the conditions of connection to the claimant and the activities of the company had ceased to be satisfied before the disposal. That group of amendments comes out of representations made by the Institute of Chartered Accountants in England and Wales, an organisation with which I have—I hope—a healthy and lively relationship. The amendments suggest that the change in the qualifying period would be consistent with the conditions for the exemption from tax on gains realised by companies on disposals of substantial shareholdings. However, the effect of the amendments would be a significant relaxation in the targeting of entrepreneurs relief on people withdrawing from business.
The hon. Member for Runnymede and Weybridge asked whether the lack of entrepreneurs relief discouraged renewal of business assets. Where a continuing business replaces business assets, rollover relief is available, and that has not changed. We do not believe, therefore, that entrepreneurs relief is needed in those circumstances. It is aimed at disposals of business and includes closing a business down.

Philip Hammond: Does the Financial Secretary accept that in the absence of amendments Nos. 19 and 20, there is an artificial restriction? She is right in what she says, but can she not envisage a situation in which, in the course of winding down or selling a business, the qualifying requirements that one holds a minimum of 5 per cent. of the shares and is an office holder or employee will cease before the final disposal is made? What she is doing is denying relief in those cases. It seems to us from a common-sense point of view that in such cases the Government would not want to deny relief, other than for money-saving considerations. The measure will invite people to structure deals and transactions purely for tax purposes. Her predecessor, with whom I used to have interesting discussions, felt very strongly that that was not the way to go forward.

Jane Kennedy: I hope that we have interesting conversations about these subjects. I want to respond to the hon. Gentleman in the spirit in which he is probing on this matter. I do not believe that this measure will have the effect that he has described, but it is another of those areas on which I will keep the impact of the reforms that he is drawing to my attention under review. I do not believe that his concern is justified.

Mark Field: One of the biggest concerns with any artificial tax-driven deal that is created as a result of these proposals is that in 12 or 24 months’ time we will face another Finance Bill and it will contain clause upon clause of anti-avoidance measures. That is what has happened in the past because the Treasury has constantly and understandably been playing catch-up with professional advisers who are able to create artificial mechanisms. We are concerned that a future Finance Bill Committee will have to consider such measures to alleviate, from the Treasury’s point of view, problems that arise with artificial creations that come as a result of ill-thought-through measures such as this. All that we are asking the Financial Secretary is that, for once, we be wise before the event.

Jane Kennedy: The hon. Gentleman is right. There are many occasions when behaviour changes as a result of changes in the tax regime. That was the point made by the hon. Member for Runnymede and Weybridge on the way in which decisions relating to the disposal of assets might be influenced by the application of entrepreneurs relief. With even the best structured tax regime for capital gains tax and given the most detailed thought, there will still be tax advisers whose whole purpose is to advise businesses on how to manage their investment decisions and their decisions on the disposal of assets to their advantage in tax terms.
We are talking not about people evading tax but about businesses making decisions based on the tax regime within which they function. I accept the point that the hon. Gentleman is making, but we believe that, by introducing much-desired simplicity by making changes to capital gains tax, we will reap benefits for businesses in the coming months and years. Even if we had changed the regime as suggested by the Conservative party in its amendments, tax advisers would still be working hard to find ways of minimising the tax liabilities for their clients. While the hon. Gentleman has made a point worth making, it is not relevant. I suspect that we shall be doing what he suggests that we shall be doing anyway. [Laughter.]
Businesses will continue to be set up for a variety of commercial reasons. The hon. Member for Runnymede and Weybridge asked why there were differences for sole traders and partnerships. Tax, including the possible availability of entrepreneurs relief, will be just one factor that people might want to take into account when deciding the business structure that is right for them. I acknowledge that the tax regime does influence decision making, but it is not the only factor.

Philip Hammond: Of course, the Minister is right, but let us suppose that I am a sole trader setting up a new small business. I expect to have business assets that I might like to sell and on which I shall receive entrepreneurs relief. Why would I not set up the business as a limited liability partnership with my wife rather than as a sole trader, knowing that if I just take the simple step of establishing it as a limited liability partnership—or even an ordinary partnership—I would be able to sell business assets and gain the benefit of entrepreneurs relief without having to cease the business? That seems a perverse signal to send; it would cause people to structure their businesses in an unnatural way simply for tax advantages.

Jane Kennedy: Any tax relief will have pressure around its edges. I accepted the point about how the regime might influence behaviour, and the hon. Gentleman has now described more than one way in which it may be perverse. We believe that the rules, as drafted, strike a reasonable balance with clear conditions, but I have said that I shall keep the relief under close review.
Amendments Nos. 14 to 16 would have the effect that I have described. They would allow disposals to qualify for relief, even if the individual was not withdrawing from business. Amendment Nos. 17 to 20 would allow the assets to be switched away from businesses, but to continue to qualify for relief. Amendment No. 15, perhaps unintentionally, would prevent some disposals following the cessation of a business from qualifying for relief as, in certain cases, assets would not meet the new test of having been in business use up until the point of disposal.

Philip Hammond: I am grateful to the Minister. She is reading out the answer to the points that have been made, but will she think about what she is saying? Let us consider the example of the factory and its disposal. The right hon. Lady said that, if an asset becomes used for a non-business purpose, it ceases to be eligible for entrepreneurs relief. In the course of disposing of a business, it would be unsafe to switch the business to new premises and then dispose of the old premises that were held outside the business as assets of the individual because they would then be disqualified from eligibility for entrepreneurs relief. It is that sort of micro-management and how the decision process is taken that we consider will be so debilitating, unnatural and inhibitive of the way in which people would normally handle such matters.

Jane Kennedy: The hon. Gentleman has described a further example of the way in which behaviour might be affected by the relief, as provided. We do not expect that that would be the effect. However, for those reasons, as I have said, I will keep the matter under close and active review.
All the amendments are unnecessary. In constructing schedule 3, we have deliberately focused entrepreneurs relief on individuals disposing of all or part of their business. It is the people who have built up a successful business whom we want to reward, and the benefit of the 10 per cent. effective tax rate will be of most value for business owners and material investors at the point of disposal. Broadening the scope of the relief in the way proposed, to allow a wider range of assets or looser connections to the business activity to qualify, would necessarily dilute this focus.
Having heard my response to his opening speech to the amendments, I hope that the Member for Runnymede and Weybridge will accept the further detail, which I hope I have provided, and not press his amendments to a vote. We are in his hands. If he chooses to press them, I will invite my hon. Friends to resist.

Philip Hammond: I am disappointed by the right hon. Lady’s response because I do not feel that she has engaged with the specific issues raised. She talked about simplification; surely it must be obvious to anyone on the Committee listening to the debate and reading schedule 3 that this is not a simplifying measure. This late amendment, the entrepreneurs relief, has hugely complicated the Government’s proposals on capital gains tax. In fact, it has removed the only benefit of the original package, which was so abruptly introduced but, in its favour, did simplify the system. Grafting entrepreneurs relief on top of the proposals makes them hugely complex.
The Financial Secretary talked about the incentive for tax advisers to develop all sorts of planning scenarios. In the real world, where the maximum tax savings will be £80,000, only the simplest planning strategies will be implementable. People will not be able to go to large firms of accountants and have them establish very complex tax planning strategies, because the amount of tax to be saved simply will not justify it. I am pleased, but alarmed, by the number of matters that she has agreed to keep under review. I can see that the Government are going to have to appoint a new person to the Treasury Front-Bench team—the under-secretary for reviews of the Finance Act 2008. If the hon. Lady keeps all these matters under review, she is going to be very busy.
We have tabled these amendments to be helpful and to probe the Government’s intentions. There is still a lot of uncertainly out there about what this regime will mean in practice. I had hoped that the Financial Secretary would clarify at least the Government’s intention today. Our fear and our belief is that this was done in a great hurry in response to pressure from business organisations and particularly from the Federation of Small Businesses, which should get a mention for its success in getting this huge climbdown for small businesses.
Some of the consequences that I have spelt out and will be spelling out in future debates were not intended. They were not the result of some great Government plan to deprive this or that person. They have fallen through the cracks of hastily drafted legislation. We were hoping that the Minister would do more than undertake to keep under review some of these issues, particularly the requirement for employment or office holding. Later we shall come to the requirement for a 5 per cent. share holding. I had hoped that she would undertake to review such issues before Report. I sense that the mood of the Committee is that we have a great deal to get through and we want to discuss many other areas in schedule 3. Therefore, in the interests of time, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Philip Hammond: I beg to move amendment No. 21, in schedule 3, page 120, line 39, leave out ‘the individual’s personal company’ and insert ‘unlisted’.

Frank Cook: With this it will be convenient to discuss the following amendments: No. 22, in schedule 3, page 127, leave out lines 37 to 42.
No. 38, in schedule 3, page 127, line 37, leave out from ‘company”’ to end of line 42 and insert
‘has the same meaning as in section 165(8).’.
No. 39, in schedule 3, page 127, line 39, leave out ‘5%’ and insert ‘1%’.
No. 40, in schedule 3, page 127, line 41, leave out ‘5%’ and insert ‘1%’.
No. 41, in schedule 3, page 127, line 42, at end insert ‘, or
(c) in which he holds shares under an approved HMRC share scheme.’.
No. 42, in schedule 3, page 127, line 42, at end insert ‘, or
(c) in respect of shares in which he holds EMI qualifying options.’.
No. 5, in schedule 3, page 127, line 42, at end insert—
‘(3A) Shares held by an individual through an employee profit sharing scheme or a share-ownership scheme shall be exempt from the requirements of subsection (3).’.
No. 43, in schedule 3, page 128, line 9, at end insert—
‘“EMI qualifying options” has the meaning given in section 527(4) of the Income Tax (Earnings and Pensions) Act 2003,’.

Philip Hammond: Again, I intend to address the issues raised in this group separately, but they all deal with the circumstances in which a sale of shares is a qualifying disposal for entrepreneurs relief. Amendments Nos. 21 and 22 challenge the requirement for a 5 per cent. holding of shares. There was no such requirement in relation to taper relief or in relation to the share in a limited liability partnership. Limited liability partnerships are an alternative form of business structure and are comparable to incorporation for a smaller business. That rule seems to have been lifted from retirement relief and not updated to reflect the emergence of limited liability partnerships, as I said earlier. That is onerous for those in high-tech industries, for example.
The hon. Member for Dundee, East raised some points raised by the BioIndustry Association. It has drawn attention to the fact that in capital-intensive start-up areas to which highly skilled employees need to be attracted, it is not unusual to give employees shares or share options in the business. It would be unlikely that anyone but the most lucky employee or one of a group of founders—perhaps those who came out of a university and set up a high-tech business—would hold more than 5 per cent. of the shares each after they had suffered a number of dilutions during the capital-raising process of taking their business forward. That is a function of the fact that significant equity needs to be released in order to attract the capital.
Therefore, I invite the Financial Secretary to think about the example of five brilliant bioscientists leaving a university and setting up a business on the Cambridge University science park. Over the years, they first raise £500,000, and then another £500,000, but on each occasion they will have to give away part of the equity in the business until they come to the point at which they are reasonably successful. They would be ready to dispose of their company by perhaps floating it on the stock market or selling out to a much larger company, but by that stage the five of them would have between them only 24 per cent. of the original equity. They will not qualify for entrepreneurs relief, and to me that is a bizarre situation.
With the greatest respect to small businesses, many people go into business and establish small companies, not with the intention of creating a large business, employing lots of people, floating it on the stock market and creating millions of pounds of wealth, but simply with a view to having a comfortable lifestyle and engaging in useful and remunerative activity, which is very worthy. Such small businesses are the backbone of our society, and I applaud them. However, in economic terms, we should focus on those who start businesses with a view to turning them into the Googles, the Microsofts and the major biotech companies of the future. It is on those businesses that the Government should focus their attention.

Stewart Hosie: I think that I have just discovered a double whammy. I had not considered the dilution of shares at the back end in the way that the hon. Gentleman has. The dilution of shares will be intensified by this measure precisely because the outside investor, if they want the same cash return with the new tax regime, might demand more from the pot. Therefore, the scenario described is now more likely under the new rules than it was before.

Philip Hammond: The hon. Gentleman is giving me more credit than I deserve, because I had not discovered that, but the logic of what he says is absolutely right. I am sure that risk-taking investors, faced with alternative asset classes with similar tax treatment and perhaps with other opportunities elsewhere in the world, will certainly look for compensation for the reduction in post-tax return that they will receive. Why should high-tech, high-capital requirement business be disadvantaged as compared to low-tech, low-capital requirement business? That does not look like the forward-looking, technological focus that I would expect from a Government who were thinking about this country’s future.

Emily Thornberry: Will the hon. Gentleman help with this point? Would not amendment No. 21 simply allow the tax relief that the Government wish to give to entrepreneurs to be given to the stock exchange? That tax relief would therefore be available only to investors, not to entrepreneurs. It turns the whole idea of the tax relief on its head.

Philip Hammond: The relief would be available to investors in unlisted shares. The hon. Lady used the term stock exchange. It would not be available to investors in stocks quoted on a stock exchange. That is the point of inserting the term “unlisted”. It reflects the taper relief regime where unlisted shares—and under the terms of that regime, also shares quoted on the alternative investment market—were, in most cases, treated as unlisted investments. Unlisted investments were eligible for taper relief.
I would be delighted if the Minister said that she could not accept the amendment in the terms in which it is phrased, but that she accepted the point behind it and would address it in another way. The point we are trying to get to is about the 5 per cent. threshold. Let me be frank with her. I have a vision of the person drafting the measure. In his mind, he has a small factory—perhaps in Birmingham, Erdington—that is bashing something out. There are boxes going out the door and there is a hard-working entrepreneur who owns 100, 50 or 33 per cent. of the business. That is the business that the draftsman has in mind, and when thinking about that type of relatively low-capital business, I can understand his insertion of the 5 per cent. limit. However, when we look at the kind of high-tech, high-capital businesses—perhaps those growing up around our universities—which we so desperately need to promote and foster, the 5 per cent. threshold starts to look like wishful thinking and an absurdly high bar that we are asking people to clear.
As I said on Second Reading, it seems bizarre for the Government to reward investors in buy-to-let properties and owners of second homes with a lower tax rate, to give owners of small, low-capital lifestyle businesses a lower tax rate, but to say to those who risk their capital and earning potential by working, founding and investing in high-tech, potential high-growth businesses, which form the British winners of tomorrow, that they must pay a relatively high rate of tax. It is a bizarre signal to send, and I cannot believe that the Government wanted to send that message to those people. That is why I would be delighted were the Minister to accept, or at least recognise, our concerns, even if she cannot accept the amendments in the precise terms in which they are drafted.
Amendments Nos. 21 and 22 replace the definition of a personal company with the phrase “unlisted” company. I have deliberately not defined unlisted company. There are various ways in which it could be done. As I said earlier, under taper relief it included companies listed on the alternative investment market, although that is not essential. Why should the relief be more restrictive than it was under taper relief, when everything under the entrepreneurs relief is subject to the overall £1 million cap?
Before I sit down, I want to return to a specific point relating to enterprise management initiative options, which was raised earlier by the hon. Member for Dundee, East. In high-tech industries, such measures will almost always result in holdings of less than 1 per cent. on exercise. I have a question for the Minister. The enterprise management initiative was created by the Government to encourage these people. They are now going to be penalised. They make a conscious choice to take risk and to be remunerated by capital gain rather than going to work for a big company and being remunerated through income.
A concern being expressed by professional bodies is that the way in which EMI options are treated by the schedule suggests that the Government have lost interest in them, have had a change of heart and are signalling that they should no longer be used as the preferred route to incentivise employees in these businesses. I should be grateful if the Minister answered that challenge and, if I have got it wrong, gave a categorical assurance that the Government remain committed to the EMI regime.

Stewart Hosie: The way in which it has worked historically is that the banks would facilitate the purchase of the shares for a day or so to allow them to be sold. Given that they now need to be sold for a year, given that there is a very tight credit squeeze and given the market uncertainty, far from being an incentive, it might be that someone simply cannot raise the money to crystallise and make the profit and they would be landed with a liability.

Philip Hammond: The hon. Gentleman is right and I wonder whether the Minister and her colleagues have thought this through. The point about an option is optionality. One sits on it and hopes that it will have value but it does not have a downside. If it does not have any value, one has not lost anything. One turns around and walks away from it. As soon as anyone exercises that option, as they will be required to do to gain the benefit of entrepreneurs relief, and acquire the underlying shares, they will be exposed to risk. They could collapse in value. The company could become insolvent. They could reduce to zero in value. It is not about a bank lending for a couple of days. It is about a bank lending for a year and being prepared to take the full risk of something happening to that business during that time. Options and shares are not interchangeable in that way. Shares represent a capital risk. Options represent an opportunity with no downside risk.
That was amendments Nos. 21 and 22. There are lots more amendments in the group. Amendment No. 38 explores a different approach to the same problem and one which would simplify and introduce consistency within the Taxation of Chargeable Gains Act 1992, which this schedule amends. Amendment No. 38 substitutes in new section 169S at page 127 line 37 for the existing definition of a personal company as a trading company in which an individual holds at least 5 per cent. and is an officer or employee, a definition that is already in section 165(8) of the Taxation of Chargeable Gains Act. That definition is 5 per cent. of the voting rights. It is not as loose as I would like, but it is a looser definition than the one which has been imported from the old retirement relief into the entrepreneurs relief schedule.
If the Bill is enacted we will have a situation where the Taxation of Chargeable Gains Act will define a personal company in two different ways. It will define it at section 165(8), as amended, as being a company in which an individual holds 5 per cent. of the voting rights, with no obligation whatsoever to own 5 per cent. of the ordinary shares, and it will define it in respect of new section 169S as a requirement to hold both 5 per cent. of the ordinary share capital and 5 per cent. of the voting rights. It is a reduction in flexibility, an unhelpful complication in the Act and an additional impediment in the raising of capital having to have 5 per cent. both of the ordinary share capital—that is to say the beneficial economic interest in the business—as well as 5 per cent. of the voting rights.
Amendments Nos. 39 and 40 represent yet another approach, which I hope will tempt the Minister. The point here is to show her that there are a number of ways of tackling the problem. Amendments Nos. 39 and 40 would accept the Government’s architecture of a minimum percentage requirement for voting and ordinary shareholding, but make it less of a threshold by replacing 5 per cent. with 1 per cent. If the Government insist on having a threshold, we can at least make it a level that is unlikely to trip up entrepreneurs.
So far, we have heard no explanation whatsoever of the purpose of a 5 per cent. threshold. We have not heard any rationale for it being set at 5 per cent. We know very well that there is no rationale. It was just lifted from the provisions on retirement relief. Whether the threshold is abolished, reduced to 1 per cent. or limited to voting rights only and made consistent with the rest of the TCGA, will the Minister explain why the requirement is in the Bill and why it has been set at that level?
Amendment No. 41 takes us back to the debate that we had in relation to schedule 2. One group of losers from the restructuring of capital gains tax is holders of shares in approved employee share schemes. I heard the Minister say earlier that she doubts the figures provided by ifs ProShare, which suggest that 270,000 employee shareholders—quite a small percentage of the total; I think that it is 16 per cent. or a little less—would have gains that exceeded the annual exemption limit. Of course, the vast majority of them will not. Most people who are members of the Tesco employee share plan will have a relatively small holding and will make gains that are comfortably within the annual exemption limit. I accept that.
With the greatest of respect to the right hon. Lady, while I think that we all welcome employee share ownership in large and small companies, I do not think any of us would argue that employee share owners in Tesco are as necessary and vital a driving force to the future expansion of business as employee shareholders in small start-up high-tech businesses, where the incentive of owning shares is a key part of the package that drives the business forward. Those are the kind of businesses that double in size every year. Although it may sometimes seem to us—[Interruption.]I am concerned, Mr. Cook, at the possibility of another by-election. I hope that the hon. Member for Ealing, North will recover his composure in a moment.
It may seem to us sometimes when we read the newspapers that Tesco doubles in size every year, but I can assure members of the Committee that on closer inspection they will find that it does not. The Minister said last week in the Chamber, in response to something that I said about employee share ownership:
“Our figures show that the average amount of gain that a typical employee makes from save-as-you-earn options is well under the annual exempt amount of £9,600 a year, but”—
she said presciently—
“I have no doubt that we will return to that point in Committee.”—[Official Report, 28 April 2008; Vol. 475, c. 66.]
Well, here we are.
As I am sure has been discussed under the previous schedule, the old CGT regime meant that basic rate taxpayers who held shares in their employer for at least two years were subject to only a 5 per cent. CGT charge, or 10 per cent. for higher-rate taxpayers. They face an additional 13 per cent. tax on any gain above £9,600 because they are not eligible for entrepreneurs relief. It does not seem likely that the Government would wish to argue for that.
In the quotation that I gave from the Chamber last week, the Minister said:
“Our figures show that the average amount of gain that a typical employee makes ... is well under the annual exempt amount”.—[Official Report, 28 April 2008; Vol. 475, c. 66.]
But in an answer to the hon. Member for Edmonton (Mr. Love) on 12 December, when he asked for an estimate of the number of individual members of save-as-you-earn schemes that would be affected by the changes introduced by the recent Budget, she said:
“The information requested is not available.”—[Official Report, 12 December 2007; Vol. 469, c. 620W.]
I would be grateful if she could tell the Committee when the information that she was apparently quoting last week in the Chamber became available, and in what form that information was collected.
The amendment extends the definition of a personal company to include a company in which the individual holds shares under an HMRC-approved share scheme, regardless of the percentage of shares held. Surely the Government have to send a consistent message. If they no longer wish to encourage employee shareholding in companies that will grow, and in which that shareholding will therefore become worth significantly more than the annual exemption limit, let them say so clearly. I would hope that that is not the Government’s position and not the case that the right hon. Lady wishes to argue.
Amendments Nos. 42 and 43 take us back to EMI options, the importance of which we have discussed. EMI options were introduced in the Income Tax (Earnings and Pensions) Act 2003, but it is no good introducing these things as an incentive to people and then snuffing out the signals that they are meant to send with subsequent legislation. That not only erodes the value of the initiative, but undermines confidence in future initiatives and weakens the signal that the Government seek to send with similar initiatives in the future.
Amendment No. 42 adds a company in which the individual holds EMI options to the definition of a personal company, again without a percentage requirement. That allows for sale of the options, rather than having to exercise them, addressing the point that the hon. Member for Dundee, East made in an intervention. Allowing the options to be realised with eligibility for entrepreneurs relief, avoids the need to raise the finance and to take the risk of holding a capital asset and possibly seeing it depreciate over a year—getting the timing wrong. That would send a powerful signal in favour of the EMI regime.
The Minister should not underestimate the concern among professional bodies that the Government’s apparent abandonment of EMI in the set of provisions is sending a signal that the Government are no longer committed to it. I am not an expert in those areas, but I understand that professional bodies have already picked up signals from the Government that they may no longer be as keen on the EMI scheme. If that is not the case, it would be helpful if the Minister could make an unambiguous statement of the Government’s commitment to the EMI scheme. The amendment adds a provision that options under EMI qualify the individual under the entrepreneurs relief regime, and it inserts into the relevant section the definition of EMI taken from the Income Tax (Earnings and Pensions) Act. I look forward to her comments.

Jane Kennedy: The group of amendments seeks in one way or another to relax the conditions under which disposals of shares and securities can qualify for entrepreneurs relief. Amendments Nos. 21 and 22 would remove the 5 per cent. shareholding requirement and extend the relief to any holding of shares or securities in an unlisted company. Amendment No. 38 also seeks to remove the 5 per cent. shareholding requirement. Amendments Nos. 39 and 40 seek to dilute the 5 per cent. shareholding and voting rights requirements to 1 per cent. Amendments Nos. 5 and 41 to 43 seek to extend relief to shares acquired under employee share schemes or the enterprise management incentive scheme. Again, all those amendments are unnecessary.
In constructing schedule 3, we have deliberately focused entrepreneurs relief on individuals who own their own business or a material stake in a company. The relief is designed to promote and reward substantial investment and involvement in a business. We consider the 5 per cent. shareholding test to be a suitable benchmark for that purpose. The hon. Gentleman has spoken at length about why he thinks that we arrived at 5 per cent. However, entrepreneurs relief is targeted at those with a material stake in a company and those who play an active role in it. The right to vote is an important part of defining that activity. The rules, therefore, require the qualifying 5 per cent. material stake in the company to be accompanied by the same minimum percentage of voting rights. We are striking a balance between focusing relief on material investors and allowing many people to benefit from the relief and the cost of the relief. The hon. Gentleman has heard explanations for the 5 per cent. He just does not agree with the explanations that have been offered.
I shall turn now to the EMI question. May I offer him an absolute commitment to the EMI as a valuable aid to help small companies in riskier areas to recruit and retain the staff that they need to grow? Our commitment to EMI is shown by the increase in the individual limit from £100,000 to £120,000, which took effect from 6 April 2008. The impact on individual investors will depend on their personal circumstances.

Philip Hammond: I am grateful to the Minister for that clarification, which will be heard beyond this room. I am sure that it will be a welcome statement of the Government’s intentions.
I want to return to the question of the Government’s apparent obsession with the idea that they want entrepreneurs relief to be available only to people who have a material interest in the business. [Interruption.]

Frank Cook: Order. May I ask Members seeking to hold a conversation to do it outside or to desist?

Philip Hammond: I want to ask the Minister if it is her view that a 4 per cent. interest in a company that has grown to be worth £10 million is less material than a 40 per cent. interest in a company that is only worth £1 million? That is not how I think about the growth of companies and the development of the economy.

Jane Kennedy: In defining what we mean by interest and a material stake in the business, we drew the line at 5 per cent. We believe that that was the right balance to strike. I accept the example that the hon. Gentleman gave of five young students coming out of university and investing in the way in which he described. If the capital gain were split between the five equally, they would not receive the relief. In seeking to define what we meant, we have arrived at the definition that I have described. We believe that it strikes the right balance.
Some of the amendments in this group make reference to employee share schemes. Some of the schemes, such as the share incentive plans, and capital gains tax relief, remain in place, while the vast majority of participants, including the save-as-you earn schemes, have capital gains well below the tax-free annual exempt amount. In all cases, the income tax and national insurance benefits of scheme membership remain in place. We do not believe that it is—

Jeremy Browne: I did not mean to stop the Minister mid-sentence. What assessment has she made of the additional cost to the Exchequer if the Government were to accept the amendment tabled by the Conservative spokesman to reduce the threshold from 5 per cent. to 1 per cent. ownership of the company?

Jane Kennedy: I do not have that figure immediately in front of me. If we have a figure for it, I will supply it to the Committee. It is not material to the consideration of the amendments themselves. We do not believe that the amendments are necessary in principle. It is not necessary or desirable to connect the shareholdings described in some of the amendments—that is the share incentive plans and the save-as-you-earn schemes—to the entrepreneurs relief.
Having heard my remarks in response to the amendments, I hope that the hon. Member for Runnymede and Weybridge will not press them to a vote, but if he does choose to do so, I hope that my hon. Friends will resist.

Philip Hammond: I am, once again, disappointed. I do not get the impression from the Minister’s response to that group of amendments, as I did from her response to the previous group of amendments, that she was even listening to the issues. There was no sense of a thoughtful response or even a concession that there might be a grain of something that needs to be “kept under review”—to use her phrase.
I do not want to labour the point, but I sometimes wonder whether Ministers and those who advise them understand at all how small and medium businesses work and what motivates the people who get involved in them. The message going out from here is very negative. It is sending the wrong signal to all sorts of people. We have heard that the Government are now in “listening mode”—they switched to listening mode on Sunday morning. I would have thought that in the spirit of that listening mode the Minister would have wanted to look at some of these issues again because the 5 per cent. limit is a problem; it will exclude people who should not be excluded and it will preferentially treat lifestyle businesses while penalising those in high-capital-requirement, high-growth businesses that really are important to the economy.
I noted the result of the last Division, and because of the arithmetic in the room I am not going to detain the Committee by pressing the amendment to the vote. Those outside will have heard that we have made the case, they will have heard that the Minister has failed to respond to it and that the listening Government are not listening as far as entrepreneurs, high-growth businesses, holders of share options in those businesses and holders of employee shareholdings are concerned. They will draw their own conclusions. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Further consideration adjourned.—[Mr. Blizzard.]

Adjourned accordingly at eight minutes past Four o’clock till Tuesday 13 May at half-past Ten o’clock.